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David Iben put it well when he said, ‘Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.’ So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Cisco Systems, Inc. (NASDAQ:CSCO) does use debt in its business. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company’s debt levels is to consider its cash and debt together.
What Is Cisco Systems’s Debt?
You can click the graphic below for the historical numbers, but it shows that Cisco Systems had US$23.7b of debt in April 2019, down from US$28.1b, one year before But it also has US$34.6b in cash to offset that, meaning it has US$10.9b net cash.
A Look At Cisco Systems’s Liabilities
Zooming in on the latest balance sheet data, we can see that Cisco Systems had liabilities of US$27.9b due within 12 months and liabilities of US$32.6b due beyond that. Offsetting this, it had US$34.6b in cash and US$9.08b in receivables that were due within 12 months. So it has liabilities totalling US$16.8b more than its cash and near-term receivables, combined.
Given Cisco Systems has a humongous market capitalization of US$245.5b, it’s hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Cisco Systems boasts net cash, so it’s fair to say it does not have a heavy debt load!
Also good is that Cisco Systems grew its EBIT at 10% over the last year, further increasing its ability to manage debt. There’s no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Cisco Systems’s ability to maintain a healthy balance sheet going forward. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Cisco Systems has net cash on its balance sheet, it’s still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Cisco Systems actually produced more free cash flow than EBIT over the last three years. There’s nothing better than incoming cash when it comes to staying in your lenders’ good graces.
While it is always sensible to look at a company’s total liabilities, it is very reassuring that Cisco Systems has US$11b in net cash. The cherry on top was that in converted 103% of that EBIT to free cash flow, bringing in US$15b. So we don’t think Cisco Systems’s use of debt is risky. Another factor that would give us confidence in Cisco Systems would be if insiders have been buying shares: if you’re conscious of that signal too, you can find out instantly by clicking this link.
When all is said and done, sometimes its easier to focus on companies that don’t even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.